Reasons to Love and/or Hate Inflation

First, let’s look at the headlines:

“Manufacturing data add to recession worries,” says the Financial Times. The Philadelphia Fed says its index of factory output sank to a 7-year low this month.

Stocks didn’t like the report – the Dow finished down more than 142 points. Oil didn’t like it either… it slid off its all time high. But gold seemed cheered by the news, hitting a new record high above $950. Commodities rejoiced too – with the CRB up to a new all time high of 544.

“Gold nears $1,000 as stagflation fears grow,” says another FT headline.

“The fight against inflation is being sacrificed in G7 countries to avert the risk of recession and investors are likely to seek gold as an inflation hedge,” said one trader at Nomura Securities, adding that she expects the price of gold to AVERAGE $1,000 this year.

There you have it, dear reader. The world’s leading central banks are more worried about recession than inflation. And investors are betting that they’ll cut rates further to fight it. Lower lending rates… and easier credit conditions, generally… will cause higher levels of inflation.

Until now, central banks could get away with soft money policies, because the Chinese offset increases to the supply of money with massive increases to the supply of labour. Millions of Chinese moved from the farms to the factories – lowering the price of labour worldwide… and with it, prices of consumer products.

But there are many things cheap labour can’t produce – oil, for example. And gold. And copper. And food. Copper is up 22% so far this year. Gold is up 11%. Wheat is off the charts. And oil broke through the $100 barrier just this week.

Inflation has become a worldwide phenomenon. High cost copper… expensive oil… and rich food prices are working their way into the whole global consumer price structure. Inflation in China itself is over 7%… with wages rising more than 10%. Yes, the trend toward lower consumer prices led by China and Wal-Mart seems to have bottomed out.

Now, we’re looking at higher labour costs in China… and higher prices for Chinese exports. Along with higher prices for just about everything else.

Everybody loved inflation when it pushed up their stocks and house prices. But they hate it when it boosts the cost of their bread and taxi fares. Only gold investors like consumer price inflation. Hence, the smart money is wagering that the price of gold will go up… and so is our money!

It almost makes you feel sorry for Ben Bernanke and the other central bankers. They are caught between Scylla and Charybdis… between the cannons of inflation to the right of them… and the big guns of inflation to the left. They enter the valley of death without a prayer and without a clue.

Of course, if they hadn’t been such dumb clucks in the first place, they wouldn’t have gotten themselves into this jam. But, heck, that’s what markets are for… that’s what life is for… to reward virtue and punish error. These fellows challenged the gods – pretending that they could control the markets and the business cycle. Of course, they couldn’t. All they could do was to use the old familiar Keynesian flimflam… print a little extra money so as to trick people into thinking they were wealthier than they really were.

Then, they’ll spend more and invest more. It will look just like a real boom. Over and over again – from the crash of ‘ 87… to the Asian crisis… through the LTCM meltdown… and then the big dotcom crash… followed by the mini-recession of 2001… now the collapse of subprime and the bear market in housing – the Fed reached up its sleeve and slipped out an ace.

The trick may work longer than you expect it to, but not forever. Now, Mr. Market has pulled out his pistol and placed it on the table. He’s watching carefully… if sees that old, tattered ace of spades, there’s gonna be bloodshed.

Consumer prices in the United States are rising at a 4.3% annual rate – almost exactly the same rate at which Richard Nixon declared a state of emergency and imposed price controls. Oil is over $100 and gold is nearing $1,000. If the history of the ‘ 70s replays itself, consumer price increases will hit double-digit levels within a few years… and the price of gold will shoot up over $2,500.

We doubt that it will happen like that. Because the financial situation of the United States – the world’s leading economy – is much worse than it was in the ‘ 70s. By almost any measure you can think of – household debt, government deficits and debt, stock market prices, competitive position, housing prices, trade balance, savings, net assets – the United States is fundamentally (and probably irreversibly) weaker than it was 35 years ago. That could have a surprising effect… pushing the U.S. economy deeper into the ‘stag’ part of the territory… and upping the ante for the inflationists. Deflation could hit so forcefully that price gains never have a chance.

All we know is that, now, the gods are having their revenge. And while it may be painful to investors, homeowners, workers, and just about everyone else, it is nevertheless instructive. And for a mischievous economist – still fun to watch.

“Fed fights to avoid ills of the ‘ 70s,” says a headline in the International Herald Tribune. You can guess the story. Inflation on the one hand. Deflation on the other. What’s the poor Fed going to do?

Just about everyone expects it to take the easy way out – to cut rates again in March… try to play the old trick again… and as far as inflation is concerned, well, devil take the hindmost!

But just about everyone also expects the economy to soften in the first half of the year, but somehow improve after mid-summer’s eve. As to the first expectation, we are at one with the majority. As to the second, we are on our own.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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